Export Diversification in Indonesia Evaluating Its Effectiveness in Maintaining Economic Growth Stability through Trade

EXPORT DIVERSIFICATION IN INDONESIA
EVALUATING ITS EFFECTIVENESS IN MAINTAINING
ECONOMIC GROWTH STABILITY THROUGH TRADE

NADYA NURUL HASANAH

POSTGRADUATE SCHOOL
BOGOR AGRICULTURAL UNIVERSITY
BOGOR
2015

STATUTORY DECLARATION
I, Nadya Nurul Hasanah, hereby declare that the master thesis entitled “Export
Diversification In Indonesia Evaluating Its Effectiveness In Maintaining Economic
Growth Stability through Trade” is my original work under the supervision of
Advisory Committe and has not been submitted in any form and to another higher
education institution. This thesis is submitted independently without having used any
other source or means stated therein. Any source of information originated from
published and unpublished work already stated in the part of references of this thesis.
Herewith I passed the thesis copyright to Bogor Agricultural University.
Bogor, February 2015

Nadya Nurul Hasanah
H151120401

RINGKASAN
NADYA NURUL HASANAH.
Diversifikasi ekspor di Indonesia. Evaluasi
Kefektifannya dalam Menjaga Stabilitas Pertumbuhan Ekonomi melalui
Perdagangan. Dibimbing oleh NOER AZAM ACHSANI dan FLORIAN PLOECKL
Indonesia berkeinginan untuk menjadi salah satu negara maju. Untuk dapat
mencapai tujuan tersebut, Indonesia membutuhkan kestabilan ekonomi. Akan tetapi,
ketergantungan ekspor Indonesia terhadap produk-produk dan pasar-pasar tertentu
membuat pertumbuhan ekonomi Indonesia rentan terhadap adanya guncangan
eksternal, yang berpotensi untuk mempengaruhi kestabilan pertumbuhan ekonomi.
Sehingga, hal ini menjadi penting bagi Indonesia untuk dapat menjaga ketabilan
pertumbuhan ekspornya dengan cara mendiversifikasi ekspor. Tulisan ini mengkaji
peran dari diversifikasi ekspor dalam menstabilkan pertumbuhan ekspor dan peran
dari pertumbuhan eksport yang bervolatilitas rendah dalam menstabilkan
pertumbuhan ekonomi. Hasil penelitian ini menunjukkan bahwa upaya diversifikasi
ekspor yang dilakukan Indonesia belum sukses dalam menstabilkan pertumbuhan

ekspor, sebagaimana diversifikasi ekspor ini belum mengurangi ketergantungan
Indonesia terhadap produk dan pasar tertentu. Selanjutnya, pencapaian kestabilan
pertumbuhan ekonomi di Indonesia setelah krisis tidak bergantung pada upaya
diversifikasi ekspor, tetapi dipengaruhi oleh berbagai factor lain. Oleh karena
pengaruh dari diversifikasi ekspor tidak cukup kuat untuk menstabilkan pertumbuhan
ekonomi Indonesia, kebijakan-kebijakan lain seperti perjanjian dagang dan fasilitasi
perdagangan dibutuhkan untuk membantu mendiversifikasi ekspor Indonesia.
Kata kunci: diversifikasi ekspor, stabilitas pertumbuhan ekonomi, guncangan
eksternal.

SUMMARY
NADYA NURUL HASANAH. Export Diversification in Indonesia Evaluating Its
Effectiveness In Maintaining Economic Growth Stability through Trade. Under
Supervision of NOER AZAM ACHSANI and FLORIAN PLOECKL
Indonesia wants to become one of the high-income group countries. To do this,
it needs stable economic performance. However, the dependency of Indonesian
exports on certain products and markets makes export growth vulnerable to external
shocks, potentially affecting the stability of economic growth. It is thus vital for
Indonesia to maintain its export growth stability by diversifying its exports. This
study examines the role of export diversification in stabilising export growth, and the

role of less volatile export growth in stabilising economic growth. The findings show
that export diversification in Indonesia has not successfully stabilised export growth,
as it has not reduced Indonesia’s dependency on particular markets and products.
Further, Indonesia’s achievement of economic growth stability following crises has
not depended on export diversification; it is likely driven by other factors. Since the
effects of export diversification are not strong enough to stabilise Indonesia’s
economic growth, other policies, such as on trade agreements and trade facilitation,
are needed to help in diversifying Indonesia’s exports.
Key words: export diversification, economic growth stability, external shocks.

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EXPORT DIVERSIFICATION IN INDONESIA

EVALUATING ITS EFFECTIVENESS IN MAINTAINING
ECONOMIC GROWTH STABILITY THROUGH TRADE

NADYA NURUL HASANAH

Master Thesis
as a requirement to obtain a degree
Master of Science in
Economics Program

POSTGRADUATE SCHOOL
BOGOR AGRICULTURAL UNIVERSITY
BOGOR
2015

Externally Advisory Committee Examiner: Prof Dr Ir Rina Oktaviani, MS

Thesis Title

Name

NIM

: Export Diversification in Indonesia
Evaluating Its Effectiveness in Maintaining Economic Growth
Stability through Trade
: Nadya Nurul Hasanah
: H151120401
Approved
Advisory Committee,

Prof Dr Ir Noer Azam Achsani, MS

Dr Florian Ploeckl

Agreed,

Coordinator of Major Economics

Dean of Postgraduate School

Dr Ir Nunung Nuryartono, MSi

Dr Ir Dahrul Syah, MScAgr

Examination Date : 5 December 2014

Submission Date :

ACKNOWLEDGMENT
I am very grateful to Allah SWT God Almighty, who has provided me an
opportunity to obtain a scholarship and study abroad. I would like to acknowledge the
support and contributions of the following persons towards the completion of my
thesis.
My gratitude goes to Dr Florian Ploeckl and Prof. Noer Azam Achsani, my
supervisors, for their constant support, encouragement, valuable comments and
critical contributions throughout the research process until the end.
I would also like to thank the lecturers and staff of the University of Adelaide,
especially Nicole Rizzo-Gray, Athena Kerley, Niranjala Seimon and Augustine
Bhaskarraj for their excellent support and assistance during my study.
I acknowledge with thanks the Ministry of Trade (Kemendag) and Australian

Awards Scholarship for financing my study in Indonesia and Australia. I thank my
institution, the Directorate of Market Development and Export Information, Ministry
of Trade, Republic of Indonesia for providing permission and the opportunity to
continue my studies.
I would like to acknowledge Elite Editing for giving me editorial assistance to
improve the quality of my thesis. The editorial intervention was restricted to
Standards D and E of the Australian Standards for Editing Practice.
I am grateful to my colleagues and fellows in the Applied Economics major,
and especially to the Indonesian group (lima sekawan plus one [Tesa, Shanty, Indra,
Meindro and Ari]). I really appreciate the support, togetherness and friendship we
have given one another throughout our study in Indonesia and Australia. Thank you
also to my friends in Indonesia for their support and discussion during my time in
Adelaide.
To my beloved parents and family members, I thank you for your continuous
support during my study. This study would not have been possible without your
prayers and sacrifice.
Last but not least, I thank B.A.W. for his encouragement throughout the entire
study process and for his love, support, patience and prayer. This thesis is dedicated
to You.

Bogor, February 2015

Nadya Nurul Hasanah

TABLE OF CONTENTS
LIST OF TABLES

xiii

LIST OF FIGURES

xiii

1 INTRODUCTION

1

2 BACKGROUND

2

3 LITERATURE REVIEW
Export Diversification
Export Diversification and Growth
Export Diversification and External Shock

4
4
7
8

4 DISCUSSION
Progress of Export Diversification in Indonesia
Export Market Diversification
Export Product Diversification
Export Market and Product Diversification
Indonesian Export Diversification and Economic Growth Stability
Supporting Policies
Trade Agreement
Trade Facilitation

8
9
9
12
14
15
17
17
17

5 CONCLUSION

19

REFERENCES

20

LIST OF TABLES

Table 4.1 Concentration ratio, 2004–2013
10
Table 4.2 Share of main, potential and other products, 2004–2013
12
Table 4.3 Share of main and potential products in Indonesian exports, 2009–2013 13

LIST OF FIGURES
Figure 2.1 Indonesia’s GDP per capita growth (annual %)
Figure 2.2 Composition of Indonesian exports, 1970–1987 (percentage)
Figure 3.1 Categories of export diversification
Figure 4.1 Indicators of market diversification
Figure 4.2 The concentration ratio of Indonesia’s export, 2009–2013
Figure 4.3 Change in export share based on destination regions, 2009 and 2013
Figure 4.4 The extensive margin, 1989–2013

2
3
5
10
11
12
14

1

1 INTRODUCTION
In the 1980s, as the world suffered due to the decrease in oil prices, the
Indonesian economy also felt the impact. In 1982, after more than a decade of high
economic growth, the Indonesian economy experienced negative growth. Sixteen
years later, due to the Asian Financial Crisis in 1998, for two consecutive years,
Indonesia experienced another breakdown of its economy. These external shocks
significantly affected Indonesia’s economy, particularly its economic growth.
Stable economic growth is important for any developing country seeking to join
the ranks of the high-income group countries. After showing incredible growth for
many years, Indonesia is now still in the middle-income group1. Indonesia therefore
needs to be careful in order to avoid falling to the middle-income trap. Tho (2013)
describes this trap as a ‘phenomenon’ experienced by a country that cannot escape
from the middle-income level. Indonesia needs stable economic growth to keep off
this trap and to join a high income–group country.
To maintain the stability of Indonesian economic growth, reducing the volatility
of export growth is important, as export growth is one of the factors contributing to
economic growth. Previously, Indonesian exports relied too heavily on certain
products, such as oil in the 1960s (Pangestu 1992). Due to this high dependency, the
export performance of Indonesia is vulnerable to external shocks.
More recently, export diversification has been seen as a strategy to overcome
volatile export growth. By diversifying its export base, a country will have greater
strength in facing external shocks. While external shocks may affect a particular
export product, other products not affected by those shocks might take over the share
of the affected product in its export value. In this way, export growth, and by
extension the economic growth of the country, can be kept stable.
The objectives of this study are to examine the role of export diversification in
Indonesia to support export growth and to stabilise economic growth when external
shocks occur. An examination of the role of export diversification will provide a clear
picture for policy makers and export experts in Indonesia of the importance of
diversifying Indonesian exports.
The next section presents a brief outline of the history and reasons behind
Indonesian export diversification. In Section 3, the literature on export diversification
and its relationship with economic growth and external shocks is reviewed. Section 4
discusses the progress of export diversification in terms of the market and products in
Indonesia, export diversification’s effectiveness in maintaining Indonesia’s economic
growth, and the policies supporting export diversification in Indonesia.

According to The World Bank (2013), the group income is classified based on the country’s GNI.
These groups are “low income (GNI ≤ $1,035), lower-middle income ($1,036 ≤ GNI ≤ $4,085), uppermiddle income ($4,086 ≤ GNI ≤ $12,615), and high income (GNI ≥ $12,616)”
1

2

2 BACKGROUND
Indonesia has been classified as a middle-income country since 1993. Even
though Indonesia classified as a low-income country due to the Asian Financial
Crisis, it was able to re-join the middle income group in 2003 (The World Bank n.d.).
Despite being resource-rich, Indonesia has not been able to join the group of highincome countries. For almost two decades, from the mid-1960s to the 1980s,
Indonesia experienced positive growth in its GDP per capita. However, this positive
growth was not stable: it varied between 3.5% and 9% per year (see Figure 1). The
high growth experienced by Indonesia was supported by its export of oil during the
oil boom of the 1970s. Pangestu (1992) argued that the increase in oil prices in the
early 1970s increased the share of oil exports from Indonesia and contributed to the
increase in Indonesian GDP per capita.
15

10

5

1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011

0

-5

-10

-15

-20

Figure 2.1 Indonesia’s GDP per capita growth (annual %)
Source: (The World Bank 2014b)
However, as Pangestu (1992) argued in her article, the fall in oil prices in 1982
led to a decline in the share of oil exports in Indonesian exports. Since during that
time oil was the main commodity exported by Indonesia, Indonesian exports
experienced negative growth. For five consecutive years (1982–1986), Indonesian
exports dropped, with their value decreasing significantly from US$26.85 billion in

3
1981 to US$15.60 billion in 1986 (The World Bank 2014c). This decline in exports
eventually affected the economic performance of Indonesia, as shown in Figure 1. In
1982, the GDP per capita of Indonesia dropped by around 1.16%.After the oil shock,
the Indonesian economy started to recover. Even though its exports continued to
experience negative growth, Indonesia achieved positive economic growth in per
capita terms in the range of approximately 2–7% every year (see Figure 1). However,
this positive growth did not last long. In 1998, Indonesia’s economy was hit for the
second time, by the Asian Financial Crisis. This crisis had a profound impact on the
Indonesian economy and placed Indonesia into a deep recession (Tambunan 2010).
Indonesian GDP per capita dropping by about 14% (see Figure 1). In addition to the
depreciation of its currency and the fall in economic growth, Indonesian export
performance was also affected by this crisis. Theoretically, the depreciation of the
country’s currency should have led exports to increase. However, while the share of
exports in GDP per capita growth during this period did increase significantly
(27.85% in 1997 to 52.97% in 1998), the value of exports fell dramatically from
US$60 billion in 1997 to US$51 billion in 1998. This trend of decreasing export
value continued for two years (The World Bank 2014c).

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

1969

1967

90
80
70
60
50
40
30
20
10
0

Agricultural raw materials exports (% of merchandise
exports)
Fuel exports (% of merchandise exports)

Figure 2.2 Composition of Indonesian exports, 1970–1987 (percentage)2
Source: (The World Bank 2014b)
By 2000, supported by a favourable political environment, Indonesia’s
economy had recovered from the crisis and its GDP was growing at approximately 3–
5% per annum (see Figure 1). Further, Indonesia was only minimally affected by the
2

This export composition only consists of three sectors. There are three other sectors that are not
included in this graph: Food, Ores and Metal and the Service sector.

4
Global Financial Crisis of 2007–08: GDP per capita growth dropped off to about
3.2% after four consecutive years of more than 4% growth (see Figure 1), and
Indonesian exports declined by approximately 14.47% from the previous year (The
World Bank 2014c).
The effect of the above-described external shocks changed the structure of
Indonesian exports. At the beginning of the oil boom, Indonesian exports relied
heavily on oil exports. As shown in Figure 2, during this period, oil exports
accounted for more than 40% of total exports; oil exports’ share of total exports
reached its peak in 1982, at about 82%. When the oil price started to decrease, the
share of exports from the oil sector also fell, as did the share of exports from the
agricultural sector. However, this marked the starting point for the increased
contributions from the manufacturing sector. As shown in Figure 2, the share of
exports from the Indonesian manufacturing sector increased gradually after 1982, and
in 1991, the manufacturing sector took its place as the main segment of merchandise
exports in Indonesia, contributing about 40% of total exports.
Based on its journey from the early 1960s, it is clear that Indonesia is
vulnerable to external shocks. The external shocks experienced by Indonesia affected
its economic performance, causing a slowdown in Indonesia’s progress towards
joining the high-income group of countries. This has led to recognition of the
importance of keeping export performance stable. While stable export performance
can help to stabilise a country’s economic growth, the method in achieving this is
important. The next section focuses on export diversification as the method for
stabilising economic growth.

3 LITERATURE REVIEW
In this section, the relationship between export diversification and economic
growth and external shock is discussed from a theoretical perspective, with support
from previous empirical studies.

Export Diversification
Traditional trade theory suggests that a country should focus on specialisation
rather than diversification. The Heckscher-Ohlin model states that a country should
specialise in and export the commodity which uses its abundant factor intensively
(Markusen et al. 1995). However, the urgency of diversifying a country’s export base
starts to increase since volatility in commodity prices may affect economic growth in
the long run.
Amurgo-Pacheco and Pierola (2008) stated that export diversification is divided
into two broad categories: intensive margin and extensive margin. The intensive
margin refers to an increase in the share of the existing export product. The extensive
margin is divided into two dimensions: product diversification and geographical

5
(market) diversification. The extensive margin in terms of product diversification
refers to an increase in the number of export good categories (that is, an increase in
the number of products exported). Those products can be exported to old or new
destinations. The extensive margin in terms of market is defined as an increase in the
number of market destinations (Amurgo-Pacheco & Pierola 2008). A clear graphical
instrument (see Figure 3) can be used to summarise this definition.

Figure 3.1 Categories of export diversification
Source : (Amurgo-Pacheco & Pierola 2008)
Several measurements can be used to quantify the level of a country’s export
diversification. The World Bank (2014a) gives these measurements as:
1. Herfindahl-Hirschman Product Concentration Index (HHPCI)
xik 2 1
i
∑nk=1
ni
Xi
HHPCI=
1
1ni
where:
Xi
: The total export value from country i
xik
: The export value of product k from country i
ni
: The total product exported by country i

6
This index measures the distribution of the trade value from the export
product. Ranging from 0 to 1, a lower index shows that a country has
diversified its export base, while a higher index indicates that a country’s
exports remain concentrated in limited sectors. This index has limitations, as
the lower index may not show a higher diversification if the number of
products is very low.
2. Herfindahl-Hirschman Market Concentration Index (HHMCI)
xij 2 1
i
∑nj=1
Xi - ni
HHMCI=
1
1ni
where:
Xi
: The total export value from country i
xij
: The export value from country i to country j
ni
: The total export partner of country i
This index measures the level of export diversification in terms of trading
partners (market destinations). Ranging between 0 and 1, a higher index
indicates that a country has a high concentration of exports to a few trading
partners. As the index moves closer to 0, this shows that a country has
diversified its trading partners. However, as with the HHPCI, the HHMCI has
its limitations. If the country only trades with a few partners, then the lower
index may not show the higher degree of diversification.
Even though the World Bank has assigned several criteria to assess the level of
diversification in terms of products and markets, Indonesia, through its Ministry of
Trade, has established its own calculation to measure the level of export
diversification. As outlined in the Strategic Plan of the Ministry of Trade (Ministry of
Trade Republic of Indonesia 2010), the indicator used to measure the level of export
diversification in terms of markets is the concentration ratio of market share from the
five largest trading partner countries for non-oil and gas exports. For diversification
in terms of product, the Ministry classifies 10 main export products and 10 potential
export products and calculates their share of Indonesia’s total exports.
While Indonesia’s measurements of export diversification are quite simple, they are
in fact part of the HHMCI and HHPCI. By using its own criteria, it is easier to see in
which country or product Indonesian exports are concentrated and to see the dynamic
changes in export product and destination. This will make it easier for policy makers
to identify which strategies should be implemented to diversify Indonesia’s market
destinations and export products. These measurements are explained below:
1. Concentration Ratio 5 (CR5)
CR5= s1 +s2 +s3 +s4 +s5 ;
total export of Indonesian products to country i
in whichsi =
total export of Indonesia
Ranging from 0 to 1, a low concentration ratio indicates a high level of
export market diversification, which is better for economic growth
sustainability.

7
2. Export share of main or potential products
Export share of main or potential products= s1 +s2 +⋯+s10
total export of main or potential product i
in which si =
total export of Indonesian products
Ranging from 0 to 1, export diversification in terms of product is classified
as high if the export share of main products is less than or equal to the export
share of other products (potential and remaining products). This
classification is explained in more detail later in Section 4.

Export Diversification and Growth
Exports are one channel driving the economic performance of a country. One of
the characteristics of developing countries is that they have high dependency on
primary products or particular markets. This makes a country more vulnerable to
trade shock. More than 60 years ago, ‘Raul Prebisch and Hans Singer argued that
specialisation in primary products would lead to secular falls in the purchasing power
of primary exports’ (Brenton et al. 2009, p. 1). Specialisation also places a country at
risk of instability in its terms of trade, causing effects such as a decrease in
investment (Helleiner 1986 cited in Amin Gutiérrez de Piñeres & Ferrantino 1997b).
Several empirical studies found that export diversification has a positive
relationship with growth in per capita terms. Al-Marhubi (2000) found that export
diversification plays an important role in promoting the economic growth of a
country. He discovered that countries with a higher degree of diversification and a
lower concentration in exports tend to grow faster. Amin Gutiérrez de Piñeres and
Ferrantino (1997b) showed that export specialisation, which is a source of economic
risk, had declined in Latin American countries, with export diversification having had
a positive effect on growth in those countries. In their study of the Chilean economy,
Amin Gutiérrez de Piñeres and Ferrantino (1997a) argued that export diversification
enhances economic performance. Even though export diversification occurred during
a time of structural change for Chile’s exports, it was expected that export
diversification would have a long-run effect on growth. This was evidenced by
Herzer and Nowak-Lehnmann (2006), which revealed a long-run relationship
between export diversification and growth in Chile. They further found that to
achieve higher growth, it is more important to encourage industry to export more,
rather than to increase the share of exports from high value-added products.
A number of studies have also found that export diversification can be
beneficial for a country by reducing instability in export revenue. Savvides and
Mohtadi (1991) identified export diversification in terms of products and markets as
beneficial for stabilising export revenue in South East Asia and Latin America.
Ghosh and Ostry (1994) supported this finding based on an analysis of 60 developing
countries in the period 1965–1991. They found that when there is uncertainty in
export revenue (export instability), a country should increase its savings level, as the
assets that accumulate from these savings act as insurance against times of income
uncertainty due to export instability. However, if the country has a high degree of

8
export diversification, this can reduce export instability, reducing the importance of
the increase in savings level.
From this empirical evidence, it is apparent that certain countries’ economic
growth and export stability have been positively affected by their having undertaken
export diversification. The question arises whether export stability has an impact on
growth. This is answered by Bleaney and Greenaway (2001) which revealed that
trade instability has a negative effect on countries’ economic growth through
reducing the incentive to invest in the export sector, thereby reducing overall
investment.

Export Diversification and External Shock
As mentioned earlier, external shock can affect a country’s economic
performance. The vulnerability of a country’s economic performance increases as the
country opens for international trade. Therefore, while openness to trade makes
countries specialise in certain products, dynamic changes in commodity prices have a
huge impact on their economic growth.
While such external shocks cannot be anticipated, free trade agreements (FTAs)
are one kind of trade shock that can be anticipated. In addition to being used to
increase trade volume, FTAs can also be used to reduce trade barriers (tariff or nontariff) and therefore increase the volume and value of trade. More than 250 FTAs
have been proposed and almost 50% of these have been signed and implemented
(Asia Regional Integraton Center 2014). According to Cusolito and Hollweg (2013),
FTAs can potentially result not only in trade creation through tariff reductions and
trade diversion from third parties through increased preference margins, but also in
export market diversification within and outside the region. FTAs can help to remove
trade policy barriers, which are a major obstacle to export diversification. Therefore,
FTAs may play a very important role in export diversification. However, the effects
of FTAs on export diversification are not sufficiently clear. Dingemans and Ross
(2012) argued that FTAs open new markets; however, in Latin American countries,
only a few countries under FTAs started exporting to the new countries.
Based on this review of the literature, not many studies have investigated the
effectiveness of export diversification in stabilising economic growth, in relation to
Indonesia and when external shocks occur. The next section discusses the progress of
export diversification in Indonesia and its role in stabilising economic growth in that
country.

4 DISCUSSION
This section will discuss the progress of export diversification in Indonesia, its
relation to economic growth and the supporting policies that can be implemented to
help to diversify the export structure of Indonesia. This discussion will focus on the

9
product extensive margin and market extensive margin, as defined by AmurgoPacheco and Pierola (2008).

Progress of Export Diversification in Indonesia
Under the regime of President Susilo Bambang Yudhoyono (2004–2014),
Indonesia has attempted to direct its focus to export diversification in terms of
markets and products. The concern to diversify products and markets arose after the
oil price shock affected Indonesia in the 1980s. After the crisis, ‘non-oil exports …
lagged far behind’ because of the Dutch Disease3 and other factors that made the
manufacturing sectors uncompetitive (Pangestu 1992). In response, Indonesia began
to focus on export diversification to diversify away from the oil and gas sector.
Nowadays, as Indonesia is an importer of oil and gas products; it now emphasises its
export diversification within the non-oil and gas sectors. As such, the export
diversification discussed in this paper concerns only non-oil and gas products and the
markets for non-oil and gas products.
Export Market Diversification
Export market diversification in Indonesia aims to decrease the country’s
dependency on certain markets and increase its number of trading partners. Figure 4
shows that export diversification in Indonesia is trending in the right direction, with a
gradual decrease in the HHMCI. In line with that, Indonesia has increased the number
of countries to which its products are exported. This significant increase in the
number of importing countries of Indonesian products began in 1997 following
Indonesia’s commitment to the World Trade Organization (WTO) on multilateralism
and the removal of export restrictions. Despite the substantial increase in number of
markets for Indonesian exports at this time, the HHMCI index did not change
significantly since it only showed a little decrease.

3

the discovery of natural resource that has made the manufacture sectors of the country less
competitive compared to other nations (Coxhead & Li 2008)

10
0.25

250

0.2

200

0.15

150

0.1

100

0.05

50

0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012

0

HH Market Index

Number of Markets

Figure 4.1 Indicators of market diversification
Source: (The World Bank 2014c)
Even though the HHMCI shows Indonesia has been experiencing a higher
degree of diversification, the measure used by the Indonesian government for
accessing the importance of trade partners (Concentration Ratio 5/CR5) shows that
export market diversification in Indonesia has not reached the established target of
43–47% for the period 2010–2014. Regarding diversifying markets for non-oil and
gas products, since 2009, the share of exports to the five biggest trading partners
(CR5) shows a slight upward trend (see Table 1). This means that Indonesia
continues to be heavily dependent on these five trading partner countries for its export
markets.
Table 4.1 Concentration ratio, 2004–2013
Year
CR5 (%)

2004
50.7

2005
50.3

2006
50.2

2007
48.8

2008
47.5

2009
47.9

2010
48.8

Source: (Author’s Calculation from Statistics Indonesia 2014)

2011
49.4

2012
49.5

2013
50.6

As can be seen from Figure 5, the increase in CR5 is mainly due to the changes
in composition of China’s imports from Indonesia. From 2009 to 2013, Indonesia’s
exports of coal and lignite to China escalated by more than 156% and 61%,
respectively (Statistics Indonesia 2014). China is the top coal importing country, and
Indonesia is the second biggest exporter of coal to China after Australia. However,
this number may decrease, as there have been attempts in China to propose a ban on

11
low quality coal which is Indonesia’s main coal export product (Hoyle, R & Li, Y
2013).

2013
2012
2011
2010
2009
0

10
CHINA

20

UNITED STATES

30
JAPAN

40
INDIA

50

SINGAPORE

Figure 4.2 The concentration ratio of Indonesia’s export, 2009–2013
Source: (Author’s Calculation from Statistics Indonesia 2014)
In 2009, the Indonesian government formulated the target to diversify its
exports into markets located in the Middle East, Africa, Eastern Europe and Latin
America (Ministry of Trade Republic of Indonesia 2010). However, since it is clear
that the target of export diversification was not achieved, it should be evaluated.
Success in diversifying export markets depends on several factors. Tarman et al.
(2011) discussed the competitiveness of the export product and the growth in the
target market as the main factors contributing to reaching the higher level of
diversification. They identified the African countries as the main potential market to
increase the level of export market diversification. The Middle Eastern countries are
another potential target of Indonesian export diversification, as the share of
Indonesian exports is low in this region. Therefore, export diversification efforts
should focus more on these two regions rather than on other regions.
However, these regions appears to not get the full attention of the Indonesian
government as potential main export markets. As shown by Figure 6, the share of
exports by region did not change much from 2009 to 2014. There was only a slight
increase in the share of exports to Asia, Africa and Oceania, and the share of
Indonesian exports to the Middle East saw a small decline, mainly because this region
was experiencing political and security issues that indirectly affected the regional
economy and therefore the demand for Indonesian products. As a result, the target of
export market diversification identified by Indonesia has clearly not been progressing
as expected.

12
70.0
60.0
50.0
40.0

30.0
20.0
10.0
0.0
ASIA

EUROPE

AMERICA

Export Share in 2009

AFRICA

MIDDLE EAST AUS OCEANIA

Export Share in 2013

Figure 4.3 Change in export share based on destination regions, 2009 and 2013
Source: (Author’s Calculation from Statistics Indonesia 2014)
Export Product Diversification
The Indonesian government measures export diversification using two major
categories: main products and potential products, with each category consisting of 10
products. Previously, the main products accounted for more than 50% of Indonesian
exports. High dependency on certain products can put Indonesia at enormous risk
with regard to falling export growth. As Amurgo-Pacheco and Pierola (2008)
revealed, developing countries have a tendency to concentrate their exports on
commodities with volatile demand. This volatile demand translates to instability of
income, or in other words, economic growth volatility. Diversification in terms of
export products becomes more demanding because Indonesia cannot rely only on the
main products. This makes the step taken by the government of Indonesia to promote
potential products such as leather, handicrafts and jewellery very important.
Table 2 shows a downward trend in the share of main product exports during
the period 2004–2013. Conversely, the share of potential products was varied over
this period, and was considerably smaller than for the ‘other products’ category; that
is, those products that are not a focus of export diversification in Indonesia.
Table 4.2 Share of main, potential and other products, 2004–2013
Year
Main
Product
Potential
Product
Other
Products

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

57.47

54.98

51.71

49.80

51.02

47.56

47.54

45.86

46.79

45.73

5.63

5.25

5.23

5.48

5.65

6.30

5.79

6.11

7.37

7.28

36.90

39.78

43.05

44.71

43.33

46.13

46.67

48.03

45.83

46.99

Source: (Author’s Calculation from Statistics Indonesia 2014)

13

Overall, to 2013, diversification in terms of export products showed a positive
result in line with the government target to increase the share of non-main products to
53–60% of Indonesian exports over the 2010–2014 period. As Table 3 shows, in
2013, the share of main products of Indonesian exports was only 45.73%, while
potential products and other products, respectively, comprised 7.28% and 46.99% of
Indonesian exports. This shows that the potential product share has already given the
expected result. However, upon reviewing the significant upward trend in the share of
other products of Indonesian exports from 2004 to 2013, where the increase was
greater than the result for potential products, it is necessary to re-evaluate which
products are classified as potential products. There are products that have not been
identified as potential products, but they could have the potential to contribute to
boosting Indonesian export performance.
Table 4.3 Share of main and potential products in Indonesian exports, 2009–2013
Product

Type

Palm oil
Main
Textile and textile
Main
product
Forestry product
Main
Electronics
Main
Rubber and rubber
Main
product
Automotive
Main
Footwear
Main
Shrimp
Main
Cocoa
Main
Coffee
Main
Share of Main Products
Processed food
Potential
Jewellery
Potential
Fish and fish products
Potential
Handicrafts
Potential
Spices
Potential
Medical instruments
Potential
and appliances
Stationery, non-paper
Potential
Essential oil
Potential
Leather and leather
Potential
product
Medicinal herbs
Potential
Share of Potential Products
Share of Other Products

2009
10.63

Share of Export (%)
2010
2011
2012
10.38
10.65
11.50

2013
10.56

9.50
6.85
8.90

8.65
6.74
8.13

8.18
5.51
6.69

8.15
5.75
7.01

8.46
6.03
6.45

5.04
1.77
1.78
0.87
1.37
0.85
47.56
2.86
1.22
0.89
0.58
0.25

7.22
1.98
1.93
0.72
1.15
0.63
47.54
2.59
1.12
0.83
0.47
0.32

8.86
1.88
2.04
0.72
0.70
0.64
45.86
2.62
1.60
0.79
0.41
0.28

6.84
3.09
2.30
0.79
0.54
0.82
46.79
2.94
2.11
1.01
0.45
0.44

6.27
2.95
2.57
0.99
0.66
0.78
45.73
3.22
1.84
0.92
0.45
0.40

0.20
0.07
0.09

0.18
0.07
0.10

0.14
0.07
0.10

0.16
0.07
0.09

0.20
0.07
0.08

0.12
0.01
6.30
46.13

0.10
0.01
5.79
46.67

0.09
0.01
6.11
48.03

0.09
0.01
7.37
45.83

0.09
0.02
7.28
46.99

Source: (Author’s Calculation from Statistics Indonesia 2014)

14
From Table 3 it can be seen that several potential products already have a
higher share of exports than the main products. However, based on the assessment of
the Indonesian government, these products—jewellery, processed food and fish
products—are still considered as potential product due to their expected potency to
gain a greater export share.

Export Market and Product Diversification
Overall, the progress of export diversification over the years has shown that the
efforts to diversify in Indonesia are particularly focused on export product
diversification. This is supported by the composition of the extensive margin released
by the World Bank (2014a). Its definition of extensive margin is slightly different to
that by Amurgo-Pacheco and Pierola (2008). For extensive margin, the World Bank
(2014a) classified products as ‘old products’ if they had been exported to at least one
country, and it classified markets as ‘old markets’ if at least one product had been
exported to these markets.

Figure 4.4 The extensive margin, 1989–2013
Source: (The World Bank 2014c)
As shown in Figure 7, using the World Bank’s (2014a) definition of extensive
margin, from 1989 to 2013, approximately 46.78% of export growth in Indonesia
came from exporting old products to old markets. This high share occurs because,
since 1989, Indonesia has been implementing an outward-oriented strategy that
encourages export-oriented industry and the export of the resulting products.

15
Meanwhile, the product extensive margin during this period only supported 11.38%
of the export growth, while the market extensive margin only contributed 2.86% of
the export growth (see Figure 7).
The lower contribution of the market extensive margin is because, since 1997,
Indonesia has already exported to almost all countries, leaving only a few countries
that could serve as new target markets for Indonesian exports. However, since the
CR5 for Indonesian exports is still large, the target of diversifying exports should be
achieved not by adding new markets, but by strengthening Indonesia’s position in
those markets to which it is not yet a main exporter.
Meanwhile, even though the product extensive margin made a higher
contribution to export growth than the market extensive margin, it still focused on
exporting new products to existing markets rather than to new markets, because of the
dependency of Indonesia on its existing markets. The contribution of product
extensive margin to export growth is influenced by the demands of Indonesia’s
traditional trading partners:4 the United States, Thailand, Japan and Hong Kong. In
2013, Japan and the United States together account for almost 21% of Indonesia’s
exports while Thailand and Hong Kong also have a considerable share of Indonesian
exports, at more than 5% together (Statistics Indonesia 2014).

Indonesian Export Diversification and Economic Growth Stability
Regarding the efforts of Indonesia in diversifying its export base, the role of
export diversification in maintaining the country’s economic growth stability is now
assessed. This section analyses the contribution of export diversification to
Indonesia’s capacity to counter external shocks.
When the oil price shock affected Indonesia, the manufacturing sector replaced
the oil sector as the main commodity-exporting sector. This shift was extended
further by Indonesia’s greater focus on diversifying its exports. Pangestu (1992)
suggested Indonesia focus more on the manufacturing sector than on the oil sector.
During this period, the recovery of Indonesia’s economy depended on several factors.
Indonesia responded to the oil shock by significantly reducing its fiscal imbalance
and controlling ‘inflationary pressure’ (Ahmed & Chhibber 1992). Indonesia also
responded through an exchange rate adjustment that eventually affected the tradable
sector. Indonesia’s real exchange rate depreciated by 55% from December 1981 to
December 1988 (Ahmed & Chhibber 1992). Further, Ahmed and Chhibber (1992)
revealed that the trade balance from non-oil commodities increased by more than 1%
for every 1% depreciation in the real exchange rate. In addition, the Indonesian
economy became more open to international trade as the government implemented
trade liberalisation policies and focused more on industrialisation so that its economy
could recover from the oil shock (Elias & Noone 2001). The low export
diversification did not help during the crisis and the recovery process involving
There is no certain definition of the term ‘traditional’, but the partner countries that have a long trade
history with Indonesia, such as Japan and China, have been classified as its traditional trading partners.

4

16
export growth was driven by an exchange rate adjustment that made Indonesian
products cheaper. Therefore, since export diversification was not the driver of export
growth during this crisis, it seems that export diversification had no effect on
stabilising Indonesia’s economic growth.
In 1997, the Asian financial crisis hit the Indonesian economy, affecting trade.
During this crisis, there was high pressure to depreciate the Indonesian rupiah after
the period of stability and move from a fixed to a floating exchange rate. In 1998, the
Indonesian rupiah was floated and depreciated strongly, worsening the private
sectors. Compounded by a period of political chaos in Indonesia, this crisis had a
huge impact on the Indonesian economy. Recovery from this crisis began after a
change in the political structure of Indonesia, and with the help of the International
Monetary Fund (Indonesia-Investments n.d.). Economic growth started to steady, but
the role of export diversification in this period is not clear. The value of exports
showed negative growth, and in the period 1998–1999, the fall in the intensive
margin of trade (old products to old markets) contributed more than 140% of negative
export growth (The World Bank 2014c). The extensive margin slowed decline in
export growth during this period, but it only offset certain parts of the decline in the
intensive margin. This offset was mostly shown by the market extensive margin
rather than the product extensive margin. The economic recovery and increased
stability in Indonesia after the Asian financial crisis appears to be influenced by the
extensive margin. However, since the effects of the extensive margin were not strong
enough to offset the intensive margin, export diversification appears only had a small
and weak impact on stabilising the Indonesian economy during this period.
During the Global Financial Crisis, since export diversification in Indonesia has
not been fully successful, it did not contribute to stabilising export growth as much as
was expected. From the period 2009 to 2013, Indonesian exports fluctuated. In 2010
and 2011, Indonesian export value increased to US$129 billion and US$162 billion,
respectively. However, in 2012 and 2013, Indonesian export performance
deteriorated, and the export value decreased to US$153 billion and US$149 billion,
respectively (Ministry of Trade Republic of Indonesia 2014). Meanwhile, Indonesian
economic growth in per capita terms from 2009 to 2012 remained stable, in the range
of 4–5%. This positive economic performance can be attributed to the quick response
of the Indonesian government using lessons learned from the previous crises, the
stable spending of Indonesia’s citizens and the country’s healthy banking and
financial sectors (Tambunan 2010). Indonesia’s economic growth did not show a
decrease like that seen during the other two crises, but export growth did decline.
Therefore, export diversification was not effective in stabilising economic growth and
was not sufficiently strong to offset the shocks in the international market.
The stable economic growth that has been maintained by Indonesia since 2000
does not seem to come from export diversification, as this did not successfully
stabilise export growth during the observed period. The economic growth stability
experienced by Indonesia is therefore likely driven by other factors.

17
Supporting Policies
From the discussion so far, it can be concluded that export diversification in
Indonesia has not met its targets and does not yet fully support stable export growth.
This section will review the trade policy implemented by Indonesia and identify
future policy applicable for supporting export diversification.
Trade Agreement
As Indonesia is a WTO member, its policies have to be in line with the
international trade rules set by the WTO. The Indonesian government has pursued
trade liberalisation by increasing its number of FTAs. Indonesia has signed several
agreements, including with ASEAN and Japan, and is party to the FTAs signed by
ASEAN with countries such as Australia, New Zealand, Japan, India, Korea and
China (Asia Regional Integraton Center 2014).
Refer to Figure 3 above, up to now, the trade agreements signed by Indonesia
support the intensive margin rather than the extensive margin. So far, all of the
agreements have been made between Indonesia and its old market destinations for old
export products. However, these agreements can be maximised to increase the
product extensive margin by adjusting the agreements to add the possibility to export
new products to these destinations. These agreements can be used to relax the product
standards from the importing countries, to provide exporters the opportunity to
increase their product quality to meet these standards.
To increase the market extensive margin, Indonesia should sign agreements
with new countries to export existing products. As these markets will already have
market leaders for these products, it will be difficult for Indonesia to compete. Using
FTAs, Indonesia can come to arrangements that target niche markets in these new
countries. The FTA between ASEAN, Australia and New Zealand can be an example
for Indonesia when forming this kind of FTA. Under this agreement, Australia as a
meat exporter is able to export not only beef but also game meat such as kangaroo
and offal to ASEAN countries. Unlike beef, game meats are a niche product in this
market (Department of Agriculture and Food 2010).
For now, Indonesia’s focus in FTAs should be directed to increasing the
extensive margin for new products in new destinations. In addition to giving the
opportunity to enter new markets, these agreements will allow Indonesia to
participate in forming the product standards and specifications in its partner countries.
Such FTAs will be helpful for exporters in adjusting their products to satisfy these
standards.
Trade Facilitation
‘Trade facilitation is any policy that reduces the transaction costs of
international trade’ (Dennis & Shepherd 2011). There are many forms of trade
facilitation, including the reduction in the cost for market entry and export. Dennis
and Shepherd (2011, p. 102) find that those costs have a negative impact on export
diversification in developing countries. Therefore, improving trade facilitation is

18
important to promote higher export diversification, since trade facilitation eliminates
the barrier for trade.
Due to the high cost of exporting to countries outside Asia, Indonesia’s trading
partners are mostly located in Asia; only two of its 10 main partner countries are
located in America and Europe. To reduce the cost of trade, Indonesia should focus
on improving the efficiency of its port and customs services. According to the
Organization for Economic Cooperation and Development (OECD; 2014), compared
to other lower middle–income countries, in 2013, Indonesia performed well in
providing simple documents at ports, imposing standard costs for exports and
cooperation between different parts of customs. This shows that Indonesia is
concerned with reducing trade costs, with the aim of providing a better export
environment for exporters.
The OECD (2014) states, however, that Indonesia is still lagging behind in
terms of electronic procedures and the availability of information. This increases
export costs for the exporter. Concerning electronic procedures, the export
mechanism conducte